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Many people have likely dreamt about inheriting a home or coming into real estate wealth. What they don’t realize, though, is that inheriting a home comes with its own set of unique challenges.

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Estate planning and dealing with an inheritance can involve issues that may be costly and confusing. Here we’ll look at what happens when you inherit wealth through real estate but can’t afford the taxes, and other possible issues with generational wealth.

What Happens When You Inherit Real Estate?

We recently looked at irrevocable trusts and how the rules on generational wealth had changed. Historically speaking, people with a significant amount of assets like real estate would use an irrevocable trust to pass down money to the beneficiaries tax-free. One of the biggest issues with passing down real estate to family members is the possible tax liability associated with property ownership.

When a relative leaves you real estate, you don’t have to technically pay anything to come into possession of the property once the estate affairs are settled. However, a lot happens when you inherit real estate, and you have to decide on your next step.

You have three options for the inherited real estate, according to Zillow:

  1. You can sell it right away. The capital gains that you pay will depend on the estate planning and how you inherited this property.

  2. You can treat it like a rental property and collect tenant rent payments. You’re going to have to pay property taxes and pay taxes on the income that you collect from tenants.

  3. You can move into this home. Your tax liability will change because you have to pay property taxes. This means that you could find yourself with a hefty property tax bill if you inherit multiple properties.

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What Happens When You Can’t Pay the Taxes?

Imagine that you’ve inherited a beautiful home, or perhaps you’ve come into a real estate empire. You’re excited about the prospect of this, but you’re unsure if you can cover the property tax bill that comes with this real estate. We spoke to someone who had to deal with this kind of situation. Gareth Boyd, co-founder of Forte Analytica, experienced this scenario in his own family.

“One of my close family members inherited a portfolio of income-producing properties from a relative in the family,” Boyd said before sharing the harsh reality of the situation. “While this was a substantial financial boon on the surface, the complexities of estate tax left him in a tight spot. The tax obligations were substantial, and they didn’t have the liquid assets to cover these immediate costs.”

What did the family member do to resolve this situation? “He had to make an extremely hard decision. He ended up selling off some of the properties to cover the tax liabilities, which helped them remain financially stable while keeping the rest of the real estate portfolio intact.”

The reality is that the tax liability could be too much to handle when you’re not used to owning real estate with such a high value.

What Are Other Issues With Inheriting Real Estate?

While the aforementioned story highlights what can happen when you can’t afford the taxes on inherited property, there’s another scenario that you have to watch out for. You could be inheriting real estate that isn’t worth it.

We spoke to Ashley Barnett, who inherited a house in 2013 when her father died. She lived in Phoenix, and the home was in Las Vegas. There was one major issue with inheriting this piece of property from her father. The piece of real estate was underwater, meaning that the mortgage balance was higher than the current value of the property.

“The mortgage balance was more than the house was worth, and it just wasn’t worth the effort to keep it,” Barnett said. Even though some may have an emotional connection to a property like this, Barnett knew that inheriting this real estate would be a financial burden. “I didn’t make any payments and was never even contacted by the bank about it being in foreclosure,” Barnett stated.

While you may think that you’re coming into generational wealth through real estate, you could find yourself with a financial liability as an owner of a property that doesn’t hold any value. You’re going to want to work with a tax professional if this happens to you to decide what the best course of action is.

What Are Viable Solutions for Covering the Taxes?

Estate planning is a complex topic, and it can be challenging to provide blanket statements because every scenario is unique. While the U.S. doesn’t have an inheritance tax on the federal level, some states do have this tax. If you’re concerned about property taxes, you have a few options here:

  • You can sell one of the properties to cover the tax liability. You could cash out one of the assets to give yourself a financial cushion.

  • You can rent out space in the property to help offset the tax liability. If you’ve inherited more property than you can afford, you can consider renting out space to generate income from this real estate to help with your new expenses.

As always, we suggest that you work with a tax professional who specializes in this subject manner as the results vary depending on what state you live in.

Closing Thoughts

“This experience highlights the importance of tax planning in wealth transfer and managing inherited assets,” Boyd explained.

While inheriting real estate from a relative can be a lucrative windfall, you have to consider the possible implications. It’s important that you consult with an estate attorney and a tax attorney to understand what your options are if you know that you’ll be inheriting property.

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This article originally appeared on I Inherited Generational Wealth Through Real Estate but Couldn’t Pay the Taxes: Here’s What Happened Next